The Sources of Prosperity

I am an economist so I can’t help writing about the virtues of trade in the (futile?) hope that what is obvious to economists might be better understood and appreciated by the general public. https://wcoats.blog/2016/12/22/save-trade/https://wcoats.blog/2017/01/06/the-liberal-international-order/,   https://wcoats.blog/2018/03/03/econ-101-trade-in-very-simple-terms/, https://wcoats.blog/2017/01/06/the-liberal-international-order/, https://wcoats.blog/2019/02/09/tariff-abuse/

So please bear with me one more time. If you join with ten, or a hundred, or a thousand others to cooperatively produce things, you can jointly produce much more than ten times, or one hundred or one thousand times as much as you could all produce individually as one person factories. But that huge increase in productivity and output is not possible unless you can sell your joint output to others for the many other things you need and want to consume that they produce. In short, none of this is possible without trade. The wider the area over which we can trade the greater are the possible gains in productivity from the specialization of labor and capital that a larger market makes possible. The American constitution recognized this when it prohibited restraints on trade between the states (across state lines).  The ultimate limit in the size of the market is given by the world itself.

But markets—the “places” or the arrangements through which trade deals (purchase and sales agreements) occur—require trust that deals will be honored.  The rule of law, which protects private property and the enforcement of contracts, provides the certainty needed for a manufacturer or other service provider to invest in the productive capacity and facilities needed to generate the promised supply of products that is the foundation of our relative affluence. When trade extends beyond national boundaries the rule of law takes the form of international agreements to rules of the game.  Bilateral, multilateral and global trade agreements establish the rule of law within their domains.  The World Trade Organization (WTO) was created to oversee this process. The astonishing skyrocketing of the standard of living of the average (even the poorest) earthling rest on, i.e. would not have been possible without, trade.

The uneven but persistent history of trade has seen the protection of less efficient and uncompetitive firms and industries reduced over time via trade agreements that reciprocally reduced the taxation of imports (i.e. tariffs).  Starting with President Trump’s misguided withdrawal from the Trans Pacific Partnership (TPP) trade liberalization has been thrown into reverse. Trump vs Adam Smith  TPP modernized and further liberalized existing trade agreements between the U.S. and a number of Pacific countries.  The agreement was to be between 12 Asian Pacific countries until the U.S. withdrew.  It would have provided a strong magnet to further draw China into the global system of rules for increasingly free trade. It was ultimately signed by 11 countries without the U.S. and renamed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). The US withdrawal from the agreement was a serious mistake.

The United States as well as much of the rest of the world is beginning to pay the costs of Trump’s trade wars. In January of this year Deutsche Bank estimated that Trump’s trade wars have cost the U.S. stock market $5 trillion in forgone returns so far. Costs of trade war  “Bloomberg economists Dan Hanson and Tom Orlik have… concluded: If tariffs expand to cover all U.S.-China trade, and markets slump in response, global GDP will take a $600 billion hit in 2021, the year of peak impact.” US China trade war-economic fallout  “The import tariffs proposed by President Trump could wipe out the income gains provided by the Republican tax cuts for low- and middle-income earners, Jim Tankersley of The New York Times reported Monday.”  ”Trump-Tariffs-Could-Wipe-Out-Tax-Cuts-Most-Americans”

Are Trump’s import taxes old fashioned protectionism (protecting relatively inefficient domestic industries from foreign competition), a legitimate response to national security concerns, or a reflection of Trump’s “famed” negotiating style?

Protectionism

For starters Trump’s steel and aluminum tariffs of 25% and 10% respectively (following his earlier imposition of tariffs on solar panels of 30% and washing machines of 50%) are clearly protectionist and reflect an alarming over reach of executive authority. Using the “authority” given the President under Section 232 of the Trade Expansion Act of 1962, U.S. Department of Commerce found that imports of steel and aluminum “threaten to impair the national security” of the United States.  Canadian Prime Minister Justin Trudeau called the claim that reliance on Canadian steel could be considered a national security risk “absurd”.  Trump removed these tariffs on Canada and Mexico last month, but they remain in effect on our other friends (e.g., EU) and enemies. On several occasions Trump has threatened to raise tariffs on car’s imported from Europe on the same phony national security grounds.

The patters of trade that minimize costs of production and maximize labor productivity can be complex. While protecting a few inefficient American steel producers and their related jobs might be good for those few firms, it is bad for American consumers and the economy at large. Workers in less productive protected industries are thus not available to work in more productive activities. Moreover, more jobs were lost than saved as the result of high prices and lost sales by steel importing manufactures.  One study estimated that these tariffs could result in the loss of 146,000 jobs.[1]

Peterson Institute for International Economics study estimated that American businesses and consumers paid more than $900,000 a year for each job that was created or saved as a result of the Trump administration’s tariffs on steel and aluminum. The cost for each job saved as a result of the administration’s tariffs on washing machines was $815,000.[2]

National Security

The distinction between legitimate security concerns and protectionism is not always obvious. Trump’s approach is often more protectionist and bargaining chips than concerns for security.  An early indication of this was the U.S.’s treatment of ZTE Corp, China’s second largest telecoms gear maker.  In April 2018 the U.S. band U.S. companies from selling their products to ZTE in connection with its violation on U.S. restrictions on trade with Iran, Sudan, North Korea, Syria and Cuba.  “That means no Qualcomm chips or Android software for its phones, and no American chips or other components for its cellular gear.” NYT The company was effectively shut down and heading for bankruptcy when in early June of 2018 Trump ordered these restrictions lifted to save Chinese jobs!!  According to the NYT: “The Trump administration is pressuring China to make trade concessions. It may also need Beijing’s help to strike a deal with North Korea as Washington and Pyongyang plan a high-profile meeting on June 12 in Singapore.  Mr. Trump appears to be using ZTE’s punishment as a bargaining chip in negotiations with China, rather than a matter of law enforcement.” What is ZTE–A Chinese Geopolitical Pawn

Trump’s more recent banishment of Huawei, a Chinese tech company leading the world in 5G development, from the American market and efforts to convinces our once British and EU friends to do the same provides another example. In some applications security concerns when dealing with a Chinese company may be justified, but these areas are limited and Huawei has gone to great lengths to allay those concerns. “Google has been arguing that by stopping it from dealing with Huawei, the US risks creating two kinds of Android operating system: the genuine version and a hybrid one. The hybrid one is likely to have more bugs in it than the Google one, and so could put Huawei phones more at risk of being hacked, not least by China.”  “Google warns of US national security risk of Huawei ban” FT June 6, 2019

The Trump administration has expressed its anger with the refusal of many other countries to follow its lead thus incurring a diplomatic cost as well as the economic one of restricting access to the best and/or most cost-effective products. The dangers and potential damage of using trade threats for other objections are clearly express by seven former US Ambassadors to Mexico in a joint letter published June 5: Ex US Mexico Ambassadors-Tariffs would destroy partnership we built

Moreover, the US’s exploitation of the importance of the dollar as a reserve and payment currency in forcing its political agenda on the rest of the world has incentivized the EU, Russian, China and others to look for alternatives. As another example of the growing risks of relying on American markets, Alibaba, China’s national champion internet giant whose share are currently only listed on the New York Stock Exchange, will raise its next round of capital on the Hong Kong exchange.

Bargaining

But some of Trump’s threats of tariffs no doubt reflect his approach to a trade negotiation. While it is not the usual approach to a trade negotiation, in which the parties should be looking for win-win reductions in tariffs and other impediments to freer trade, it could occasionally work to achieve greater concessions from the other side than otherwise. There is really little evidence that it has, however. The renegotiated NAFTA, given the new name United States-Mexico-Canada Agreement or USMCA, is no better than a normal review and updating of the existing NAFTA would have been expected to produce. It incorporates most of the updated provisions of the TPP, as was expected. But Trump started the NAFT review and update, by tearing up the old agreement and threatening to revert to the bad old days. Trump’s threated 5% tariff on imports from Mexico if it doesn’t do more to reduce or deal with the flow of refugees across the US Mexican border seems to be a counter example of a threat that worked.

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Donald J. Trump‏Verified account @realDonaldTrump

FollowFollow @realDonaldTrump

On June 10th, the United States will impose a 5% Tariff on all goods coming into our Country from Mexico, until such time as illegal migrants coming through Mexico, and into our Country, STOP. The Tariff will gradually increase until the Illegal Immigration problem is remedied,..

4:30 PM – 30 May 2019

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What if Trump doesn’t back down as China matches each of Trump’s escalations with new tariff increases of their own? Such a true trade war was not a necessary approach to the negotiations and could be terribly detrimental to both economies as well as those of our trading partners. Some of China’s behavior should be challenged. Its theft of intellectual property, state aid to some of its companies, and restrictions on foreign companies operating in China violate the spirit of the competitive deployment of resources to their most productive uses. But these criticisms are shared by most other countries (UK, EU, Japan, Korea, India, etc.). The US should negotiate with China together with these allies. It should use and strengthen the mechanisms of the World Trade Organization rather than ignoring and weakening it.

Even if Trump does backdown, as he generally has in the past, considerable damage has already been done that could take years to undo. The development of the cost saving, productivity enhancing global supply chains took time and were built with confidence in the rules that would apply—the rule of law. These very much included the maximum taxes (tariffs) and other regulations that would apply. The trust in that framework of rules has now been badly damaged.

Supply chains are already being restructured to reduce the risks of US policy shifts. While new arrangements may avoid or reduce these risks, they do so at the cost of efficiency.  Refusing to buy Russian booster rockets or Chinese semiconductors because of concerns that the Chinese or Russian government might exploit their companies’ products militarily or to steal our trade secrets, forces us into more expensive and/or inferior products and thus keeps us and the world poorer than otherwise. We had better be sure that the costs are necessary.

[1]  Timmons, Heather (March 5, 2018). “Five US jobs will be lost for every new one created by Trump’s steel tariffs”Quartz (publication).

[2] Long, Heather (2019). “Trump’s steel tariffs cost U.S. consumers $900,000 for every job created, experts say”The Washington Post.

About wcoats

I specialize in advising central banks on monetary policy and the development of the capacity to formulate and implement monetary policy.  I joined the International Monetary Fund in 1975 from which I retired in 2003 as Assistant Director of the Monetary and Financial Systems Department. While at the IMF I led or participated in missions to the central banks of over twenty countries (including Afghanistan, Bosnia, Croatia, Egypt, Iraq, Israel, Kazakhstan, Kenya, Kosovo, Kyrgystan, Moldova, Serbia, Turkey, West Bank and Gaza Strip, and Zimbabwe) and was seconded as a visiting economist to the Board of Governors of the Federal Reserve System (1979-80), and to the World Bank's World Development Report team in 1989.  After retirement from the IMF I was a member of the Board of the Cayman Islands Monetary Authority from 2003-10 and of the editorial board of the Cayman Financial Review from 2010-2017.  Prior to joining the IMF I was Assistant Prof of Economics at UVa from 1970-75.  I am currently a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.  In March 2019 Central Banking Journal awarded me for my “Outstanding Contribution for Capacity Building.”  My most recent book is One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina. I have a BA in Economics from the UC Berkeley and a PhD in Economics from the University of Chicago. My dissertation committee was chaired by Milton Friedman and included Robert J. Gordon.
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2 Responses to The Sources of Prosperity

  1. Jim Roumasset says:

    Right; specialization is limited by the market, and the market is limited by tariffs. This leaves three reasons for tariffs:
    1. In the case of your enemy, you might be satisfied by a lose-lose outcome if your opponent loses more than you.
    2. For a misbehaving friend like Mexico, temporary tariffs might “nudge” them into better behavior. The problem is that political leaders don’t like to be seen as pushed around so the strategy is risky.
    3. As a negotiating strategy, temporary tariffs would seem to change the payoff matrix in the tariffying country’s favor. But as soon as they figure out the new game, you lose that bargaining advantage. (They are not tarrified after all.)
    The biggest danger may be Trump’s non-credible stretching of his emergency powers. Unilateral punishment outside of the WTO framework for subjectively perceived rule violations is likely to lead to an erosion of rule-based trade.

  2. Jim Roumasset says:

    Trump is not only substituting himself (as judge, jury, and executioner) for the WTO dispute resolution mechanism, but he is “legislating” new rules for other countries to break. (I don’t like your immigration enforcement, I punish you w/ tariffs.) That invites China and others to move further away from rules-based trading and international relations.

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